Nailed It

Goddamn I love Paul Krugman.

Some skeptics are calling Henry Paulson’s $700 billion rescue plan for the U.S. financial system “cash for trash.” Others are calling the proposed legislation the Authorization for Use of Financial Force, after the Authorization for Use of Military Force, the infamous bill that gave the Bush administration the green light to invade Iraq.

There’s justice in the gibes. Everyone agrees that something major must be done. But Mr. Paulson is demanding extraordinary power for himself — and for his successor — to deploy taxpayers’ money on behalf of a plan that, as far as I can see, doesn’t make sense.

Some are saying that we should simply trust Mr. Paulson, because he’s a smart guy who knows what he’s doing. But that’s only half true: he is a smart guy, but what, exactly, in the experience of the past year and a half — a period during which Mr. Paulson repeatedly declared the financial crisis “contained,” and then offered a series of unsuccessful fixes — justifies the belief that he knows what he’s doing? He’s making it up as he goes along, just like the rest of us.

So let’s try to think this through for ourselves. I have a four-step view of the financial crisis:

1. The bursting of the housing bubble has led to a surge in defaults and foreclosures, which in turn has led to a plunge in the prices of mortgage-backed securities — assets whose value ultimately comes from mortgage payments.

2. These financial losses have left many financial institutions with too little capital — too few assets compared with their debt. This problem is especially severe because everyone took on so much debt during the bubble years.

3. Because financial institutions have too little capital relative to their debt, they haven’t been able or willing to provide the credit the economy needs.

4. Financial institutions have been trying to pay down their debt by selling assets, including those mortgage-backed securities, but this drives asset prices down and makes their financial position even worse. This vicious circle is what some call the “paradox of deleveraging.”

The Paulson plan calls for the federal government to buy up $700 billion worth of troubled assets, mainly mortgage-backed securities. How does this resolve the crisis?

Short answer: It doesn't.

This doesn't address any of those four issues. The housing market is continuing to fall. Banks still have too little capital on hand because of falling real estate asset values. Those two problems led directly to the credit crisis, and everyone is STILL trying to unload illiquid assets to raise capital and are glutting the market...just like the real estate market is glutted with unsold and foreclosed homes.

Banks are losing money or real estate assets, and they can't sell crap funny paper to anyone to raise the difference.

If banks are losing more money on real estate asset losses then they can make back by selling funny paper to the government and they have hyperleveraged their deposit assets to the point where they have zero wiggle room, they are insolvent. This is not a liquidity problem. It is an insolvency problem. The amount of assets these banks have is less than the amount that they owe, plain and simple. When that happens outside Wall Street, you go out of business.

No amount of liquidity will solve this issue. Throwing money at the banks will not solve this issue. These banks are leveraged at 20X or more...meaning the bad debt they really owe is more than 20 times what they have on the books.

They are beyond insolvent. They are criminally negligent.

This bailout will not work. It is a plan to make it to November, maybe January. It is a stopgap measure that will cost trillions. And then when this fails, the road is set for hyperinflation and the destruction of the dollar as the world's reserve currency...and our quality of life will plummet into that of a third-world country, with the police/fascist trappings that will certainly come from that. Everything is in place. The Bushies have robbed the country and are setting up one last Ocean's Eleven gambit on the way out.

America may not survive the next 12 months, people.